Sunday, August 31, 2014

Chapter 3 of Donald Gillies’ Philosophical Theories of Probability (2000) deals with Keynes’ logical theory of probability, which was taken up by the Vienna circle and logical positivists like Carnap (Gillies 2000: 25).

Keynes’ logical theory was partly inspired by the lectures of W. E. Johnson at Cambridge university, which were also attended by Harold Jeffreys who later formulated his own logical theory of probability (Gillies 2000: 25).

Keynes had finished the proofs of his Treatise on Probability in 1913, but it was not published until 1921.

Keynes’ views on probability were influenced by the intellectual climate at Cambridge university, particularly the ethical work of G. E. Moore and Bertrand Russell’s logicist work on mathematics (Gillies 2000: 27). Gillies (2000: 27) sees Keynes’ attempts to provide a “logical” foundation for probability, and particularly inductive reasoning, as inspired by Russell and Whitehead’s attempts to found mathematics on logic.

For Keynes, if the evidence h justifies a conclusion a to some degree α, then there is a probability relation of degree α between a and h, so that inductive probability is a degree of partial entailment or degree of rational belief (Gillies 2000: 31)

Keynes thought that we have knowledge of this probability relation by logical intuition or direct acquaintance, but this is a problematic part of Keynes’ theory (Gillies 2000: 31–32).

Gillies (2000: 32–33) argues that underlying Keynes’ idea that probability is objective and known by logical intuition is a problematic concept derived from Platonic ontology: that the probability relation is objective and belongs to some Platonic realm.

Keynes also thought that mathematical probabilities are expressible as numbers on a range in the interval [0, 1]; he thought that not every probability had a numerical value, and also that some probabilities can only be arranged in an ordinal ranking, while others cannot even be compared at all (Gillies 2000: 33–34).

The “principle of indifference,” which was introduced by Bernoulli as the “principle of non-sufficient reason,” is an a priori principle invoked by Keynes to determine when cases are equiprobable (Gillies 2000: 35–36). Gillies (2000: 37–46) sees insuperable difficulties with the a priori principle of indifference, such as the book paradox and wine–water paradox, which Keynes did not really solve.

While the “principle of indifference” might in some cases be a useful heuristic, it cannot be a sound logical principle, and so, since Keynes’ logical theory of probability requires it to be a successful theory, Gillies (2000: 48–49) concludes that Keynes’ overall logical theory is flawed, though important aspects of it may be salvaged, provided that the theory’s Platonist view of how the probability relation is understood and the a priori principle of indifference are abandoned (Gillies 2000: 35, 49; Runde 1994).

Saturday, August 30, 2014

As Gillies notes, the “Classical” interpretation was the earliest theory of probability and its most important statement was by Pierre-Simon Laplace (1749–1827) in his Essai Philosophique sur les Probabilités [A Philosophical Essay on Probabilities] (1814). However, it is largely of historical interest now, and has no supporters today (Gillies 2000: 3).

Laplace’s Essai Philosophique sur les Probabilités (1814) made the assumption of universal determinism on the basis of Newtonian mechanics (Gillies 2000: 16). Laplace argued that an agent with perfect knowledge of Newtonian mechanics and all matter could predict the future state of the universe. It is only human ignorance that prevents perfect forecasting, and leads us to calculate probabilities (Gillies 2000: 17). Thus probability, according to Laplace, is a measure of human ignorance (Gillies 2000: 21).

Laplace’s formula for calculating probabilities is the familiar one where the probability P(E) of any event E in a finite sample space S, where all outcomes are equally likely, is the number of outcomes for E divided by the total number of outcomes in S.

But there is an obvious limitation with this, as pointed out by the later advocates of the frequency theory of probability like Richard von Mises: what if our outcomes are not equiprobable? (Gillies 2000: 18). Thus the Classical interpretation of probability has a serious shortcoming.

As probability theory came to be increasingly applied to phenomena in the natural and social sciences in the 19th century, its limiting assumption of equiprobable outcomes was exposed as a problem, and the relative frequency approach was developed as a new and alternative theory.

Friday, August 29, 2014

The book is of great interest, because Gillies (2000: xiv) has knowledge of Post Keynesian work on probability and uncertainty, and also sees his “intersubjective” theory of probability as a compromise between the theories of Keynes and Ramsey.

Probability has both a mathematical and philosophical/epistemic aspect.

The earliest “Classical” interpretation of probability of Pierre-Simon Laplace (1749–1827), which was based on earlier work from the 1650 to 1800 period, is now of historical interest only, and has no supporters today (Gillies 2000: 3).

Gillies (2000: 1) identifies five major modern interpretations of probability, which are in turn divided into two broad categories, as follows:

The “intersubjective” interpretation of probability is developed by Gillies (2000: 2) himself.

The epistemological/epistemic group of probability theories take probability to be a degree of belief, whether rational or subjective (Gillies 2000: 2).

The objective probability theories take probabilities to be an objective aspect of certain things or processes in the external world (Gillies 2000: 2).

Gillies (2000: 2–3) argues that all the major theories of probability may be compatible, as long as they are limited to their appropriate domains: for example, objective probabilities are usually appropriate for the natural sciences and epistemological/epistemic probabilities for the social sciences.

Henry Dunning Macleod has an excellent discussion of the nature and history of the mutuum contract, the basis of modern banking, and the difference between commodatum and mutuum:

“1. The commodatum, or τὸ χρησάμενον.
There are some things which can be lent, and the borrower can enjoy their use without acquiring the actual property in them; and after having enjoyed their use, he can restore the identical things ‘lent’ to their owner. Thus, if a person ‘lends’ his horse or a book to his friend, his friend can ride the horse or read the book without acquiring the property in them; and after he has enjoyed their use, he can restore the identical horse or book to its owner. In such a case, the ‘lender’ only grants a certain limited right of ‘possession’ and ‘use’ of the thing lent to the ‘borrower’; but he does not cede the right of property in it to the ‘borrower.’ He retains in himself the right of property and possession in the thing ‘lent’; and can reclaim it at any moment he pleases, without any notice to the ‘borrower.’ In such cases, there is no sale, or exchange; and there is no new property created. In such cases, the relation of creditor and debtor does not arise between the parties. And there being no sale, or exchange, there is no economic phenomenon; consequently, such transactions not being acts of commerce, do not enter into the science of economics. Such a ‘loan’ is termed in Roman law a commodatum, and in Greek law τὸ χρησάμενον; because the ‘use’ only of the thing ‘lent’ is granted to the ‘borrower,’ but not the ‘property’ in it.

2. The mutuum, or τὸ δάνειον, or δάνεισμα.
But there is another kind of ‘loan’ in which the things ‘lent’ cannot be enjoyed unless they are consumed, destroyed, or alienated. Thus, if a person ‘borrows’ such things as bread, wine, coals, oil, meat, or other things of a similar nature, he cannot enjoy their use without consuming or destroying them; and they are lent and borrowed with the knowledge and consent of both parties, for the purpose of being consumed and destroyed. Hence, from the very nature of the case, the ‘borrower’ must acquire the right of property in such things when lent; and what he undertakes to do is to return, not the identical things lent, but an equivalent amount of other things of the same nature, equal in quality and quantity to the things ‘lent.’ So when a person ‘borrows’ money, he cannot enjoy its use, unless he is able to exchange it away for other things. Hence, the person who borrows money must, from the very necessity of the case, acquire the property in it. And what he undertakes to do is, not to restore the identical money lent, but an equivalent amount of money, at the stipulated time.

In all cases, therefore, of the ‘loan’ of such things as bread, wine, oil, meat, coals, money, and things of a similar nature, the lender cedes the property in the thing ‘lent’ to the ‘borrower,’ and he acquires in exchange the right to demand, and the ‘borrower’ incurs the personal duty to render, an equivalent amount of things ‘lent,’ but not the identical things. In all such cases a new property is created; a contract, or an obligation, is created between the lender and the borrower; and they stand in the relation of creditor and debtor. All such transactions are sales or exchanges; they are all acts of commerce, or economic phenomena, and they all enter into the science of economics. A ‘loan’ of this nature is termed in Roman law a mutuum, and in Greek law a δάνειον, or δάνεισμα. To contract a loan of this nature is mutuare, or δανείζειν. A loan, therefore, comprehends two transactions of an essentially distinct nature; but the essential feature of a loan is, that it is always the same person who restores the identical thing ‘lent’ or repays an equivalent.

The Roman jurists said that mutuum is derived from quod de meo tuum—because from being my property it becomes yours. Modern scholars, however, repudiate this etymology, however plausible it may seem. The Romans and the Greeks knew very little of their own language. Modern scholars say that mutuum is connected with mutare, to exchange; as deciduous is with decido, and dividuus with divide. But though the etymology may be fanciful, as are so many others given by Roman and Greek writers, it exactly expresses the fact. In the loan of the mutuum there is always an exchange of properties. In all cases of the mutuum, or the δάνειον, the property in the thing lent is ceded to the borrower; the relation of creditor and debtor is created between them, and the right which the creditor acquires to demand back an equivalent in exchange for the thing lent is the credit, or debt; or, as Ortolan says, the price of the thing lent. The reader must, therefore, observe that every loan of money whatever, no matter between what parties, public or private, is a mutuum, and is a sale, or an exchange, an act of commerce, and, therefore, an economic phenomenon.

VII.—THEOPHILUS ON THE MUTUUM, δάνειον OR δάνεισμα, AND THE COMMODATUM, OR τὸ χρησάμενον.

This distinction is so important that we may cite a passage from the paraphrase of the Institutes of Justinian, by Theophilus, one of the professors of law who were charged with the compilation of the Institutes, because it is more full and distinct than the corresponding passage in the Institutes:

‘A real obligation is contracted by an act, or by the manual delivery of something counted out, and this includes the mutuum, or the δάνειον. A thing is a mutuum where the property in it passes to the person who receives it; but he is bound to restore to us, not the identical thing delivered, but another of the same quality and quantity. I said so that the receiver becomes proprietor of it, that I might exclude the commodatum and the depositum; for in these latter the receiver acquires no property. But he must be bound to us to exclude the donation; for he who receives one acquires the property, but is not bound to us. I said he must restore not the identical things lent, but others of a similar quality and quantity, that I might not deprive him of the use of the mutuum. For a person takes a mutuum that he may use the things for his own purposes, and return others instead of them. For if he were obliged to give back the same things, it would be useless to borrow them. But all things are not taken as mutua, but only those which consist in weight, number, and measure. In weight, as gold, silver, lead, iron, wax, pitch, tin; in measure, such as oil, wine, and corn; in number, such as money, and in short, whatever we deliver with this intent, in number, weight, and measure, so as to bind the receiver to return to us, not the same things, but others of the same nature and quantity. Whence also it is called mutuum, because it is transferred by me to you with the intent that it should become your property (quod de meo tuum fit). But the real obligation includes commodatum, as if anyone were to ask me to lend him a book, and I lent it. But the commodatum differs widely from the mutuum. For the mutuum transfers the property, but the commodatum does not transfer it; and, therefore, the borrower (commodatarius) is bound to restore the very thing lent.’

So it is said in Roman law: ‘But it is called giving a mutuum, because from being my property it becomes yours (quod de meo tuum fit); and, therefore, if it does not become your property no obligation is created.’ But on the contrary with respect to the commodatum: ‘We retain the property and the possession of the thing lent (rei commodatae). No one by lending a thing (commodando) gives the property in it to him who borrows it.’

Thus the whole misconception which is so common among English writers has arisen from the English words ‘lend,’ ‘loan,’ and ‘borrow’ being used to denote two operations of essentially distinct natures. The French language is equally faulty; the words louer, emprunter, and emprunt are equally applied to both kinds of loan. But the distinction is clearly pointed out both in Roman and Greek law; and the Latin and Greek languages have distinct words for each operation. In the Code Napoleon the commodatum is termed prêt à usage, and the mutuum prêt de consummation. All commercial loans are mutua, and not commodata; every loan of money is in reality a sale or an exchange, in which a new property is created, which is called a credit, or a debt. And when the loan is repaid it is another exchange, by which the new property is extinguished.

No one who had the simplest knowledge of the elementary principles of Roman and Greek law, or of mercantile law, would ever have committed the mistake of confounding the distinction between the loan of money and the loan of an ordinary chattel, such as a horse, or a book, or a watch. Hence, those things only can be the subject of a mutuum which consist in pondere, numero, et mensura; or which can be estimated generically in weight, number, and measure. Such things are termed in Roman law quantitates, because equal quantities of bread, wine, oil, coals, etc., are as good as another equal quantity of the same things of the same quality, or one sum of 100 sovereigns is equal to another sum of 100 sovereigns, or one postage stamp is always equal to another of the same denomination. But, also, the Digest says mutua vice funguntur—one quantity serves the same purpose as another quantity. From this expression mediaeval jurists termed them res fungibiles, and in modern English law they are termed fungibles. In English law the former kind of loan, or the commodatum, is said to be returnable in specie, because the identical things lent are returned; the latter kind of loan, or the mutuum, is said to be returnable in genere, because only things of the same nature are returned.

It is much to be regretted that the English language has not two separate words to denote these two kinds of loan, like the Latin and the Greek, because the double meaning of lend, loan, and borrow has been the cause of great misconception among uninformed writers as to the nature of credit and banking.” (Macleod, in Macleod, Horn and Townsend 1896: 313–315).

BIBLIOGRAPHY
Macleod, Henry Dunning, Horn, Antoine E. and John P. Townsend. 1896. A History of Banking in all the Leading Nations (vol. 2). Journal of Commerce and Commercial Bulletin, New York.

Monday, August 25, 2014

Henry Dunning Macleod was a 19th century historian of banking in Great Britain, and this is a nice summary by him of the nature and history of banking:

“Here, again, great misconception prevails as to the meaning of the word banker and the nature of the business of banking. Gilbert says: ‘A banker is a dealer in capital; or, more properly, a dealer in money. He is an intermediate party between the borrower and the lender. He borrows of one party and lends to another; and the difference between the terms at which he borrows and those at which he lends forms the source of his profit.’ So a report of the House of Commons says: ‘The use of money, and that only, they regard as the province of a bank, whether of a private person or incorporation, or the banking department of the Bank of England.’ Notwithstanding the apparently high authority of these passages, which have misled so many unwary persons, these descriptions of the nature of the business of banking are entirely erroneous. In former times, there were many persons who acted as intermediaries between persons who wanted to lend and those who wanted to borrow. They were called ‘money scriveners.’ The father of John Milton was a money scrivener, but no one ever called a money scrivener a banker. At the present day, many firms of solicitors act as intermediaries between persons who wish to lend and others who wish to borrow. They may have some clients who wish to lend and other clients who want to borrow; and they act as agents between them. The first set of clients may entrust their money to the firm to lend to the second set, and the solicitors receive a commission on the sums which pass through their hands. But no one ever called a firm of solicitors who transact such business ‘bankers’; which shows that there is an essential distinction between the business of money scriveners and such a firm of solicitors and the business of ‘bankers.’ Solicitors who transact such agency business do not acquire any property in the money which passes through their hands. They receive it merely as a bailment or a depositum. They are only the custodians or the trustees of the money and it is only entrusted to their custody for the express purpose of being applied in a particular way. The actual property in the money passes directly from the lender to the borrower through the medium of the trustees or bailees, and if the latter appropriated the money in any way to their own purposes it would be a felony, and they would be liable to be punished for embezzlement. But the case of a banker is wholly different. When his customers pay in money to their account they cede the property in the money to the banker. The money placed with him is not a depositum or a bailment; it is a mutuum or creditum; it is a ‘loan’ or sale of the money directly to himself. The banker is not the bailee or trustee of the money, but its actual proprietor. He may trade with it or employ it in any way he pleases for his own profit or advantage. The banker buys the money from his customer, and in exchange for it he gives his customer a credit in his books, which is simply a right of action to demand back an equivalent amount of money from his banker at any time he pleases, and the customer may transfer this right of action to any one else he pleases, just like so much money.

When the client of a solicitor entrusts money to him, to lend to some one else, he retains the property in it until the arrangement with the borrower is completed; and then the property in the money is transferred directly from the lender to the borrower, without in any way vesting in the solicitor. But when a customer pays in money to his banker, the property in it instantly and, ipso facto, vests in the banker; and the customer has nothing but a right of action against the person of the banker to demand back an equivalent sum. So long as the money remains in the possession of the customer, it is a jus in rem; but when he has paid it into his account he has nothing but a jus in personam.

Galiani says (Delia Moneta, p. 325): ‘Banks began when men saw from experience that there was not sufficient money in specie for great commerce and great enterprises. The first banks were in the hands of private persons with whom persons deposited money; and from whom they received bills of credit (fedi di credito), and who were governed by the same rules as the public banks now are. And thus the Italians have been the fathers and the masters and the arbiters of commerce; so that in all Europe they have been the depositaries of money, and are called bankers.’ So Genovesi says (Delle deioni di Economia Civile, part II., ch. 5, § 5): ‘These monti (banks) were first administered with scrupulous fidelity, as were all human institutions made in the heat of virtue. From which it
came to pass that many placed their money on deposit, and as a security, received paper, which was called and is still called bills of credit. Thus private banks (banchi) were established among us, whose bills of credit acquired a great circulation, and increased the quantity of signs and the velocity of commerce.’ And this was always recognized as the essential feature of banking. Thus Marquardus says (Dejure Mercatorum, Lib. II., ch. 12, § 13): ‘And by “banking” is meant a certain species of trading in money, under the sanction of public authority, in which money is placed with bankers (who are also cashiers and depositaries of money) for the security of creditors and the convenience of debtors, in such a way that the property in the money passes to them; but always with the condition understood that any one who places his money with them may have it back whenever he pleases.’

A ‘banker’ is therefore a person who trades in the same way as the public banks did; they acquired the property in the money paid in; and in exchange for it they gave bills of credit; which circulated in commerce exactly like money and produced all the effects of money. And, moreover, when they bought or discounted bills of exchange, they did it exactly in the same way; they bought them by issuing their own credit, and not with money. And experience showed that they might multiply their bills of credit several times exceeding the quantity of money they held; and thus for all practical purposes multiply the quantity of money in circulation. This the essential business of a banker is to create and issue credit to circulate as money.” (Macleod, in Macleod, Horn and Townsend 1896. 199–201).

The essence of banking as an institution of capitalism has always been the taking of money as a mutuum, often with the client having the right to demand repayment of the bank’s debt to him on demand.

And it was not 17th century English goldsmiths who were the first European bankers, but banking in the sense defined above predated them by many centuries, and certainly existed not only in Italy in the Middle Ages, but also in the ancient Roman Republic and Empire too.

The business of banking as described above is not fraudulent. Thus the vision of banking as held by many Rothbardian libertarians goes against over 2000 years of capitalism.

The callable mutuum loan is – and always has been – a fundamental private business practice and, with the use of fractional reserves, the basis of banking.

This is why in the end Rothbardians – by their own criterion of being vehemently against restrictions on free, voluntary, non-fraudulent private exchanges/contracts – are actually anti-capitalist.

BIBLIOGRAPHY
Macleod, Henry Dunning, Horn, Antoine E. and John P. Townsend. 1896. A History of Banking in all the Leading Nations (vol. 2). Journal of Commerce and Commercial Bulletin, New York.

Murphy, Robert P. 2006. Study Guide to Man, Economy, and State: A Treatise on Economic Principles with Power and Market: Government and the Economy. Scholar’s Edition.. Ludwig von Mises Institute, Auburn, Ala.

Friday, August 22, 2014

The view that the subjective utility human beings derive from goods is not – or, at least, not yet – capable of scientific quantification with some objective unit of measurement is a reasonable and convincing one.

But it does not necessarily follow from this that the subjective utilities of different people are totally incomparable even in principle, as one vulgar Austrian suggests here.

If this were so, one must posit that every single person’s emotions of happiness, satisfaction and pleasure (the emotions that subjective utility must be identified with) are utterly unique and in no way resemble anyone else’s. This is a bizarre, anti-scientific, and utterly unconvincing idea: it violates everything we know about human psychology, neuroscience and evolution.

Human beings are all products of Darwinian evolution, and the mind and all its emotions (like utility) are causally dependent on the same underlying brain processes. While there is no doubt individual variation in the way people experience these emotions and the subjective utility any two people might experience from the same good is likely to be different, it still does not necessarily follow that they are incomparable even in principle.

In fact, the sciences of the brain and mind are advancing every day. Non-evasive scanning like MRI is identifying the biochemical and neural basis of human mental states and emotions. It is even conceivable that eventually science can measure the intensity of human emotions underlying “utility” objectively.

For example, already there is some evidence that MRI will one day be used to assess the intensity of pain even with an objective measure (see Wager et al. 2013, with summary here).

Curiously, even an Austrian economist like Robert Murphy admits this possibility:

“It may be that one day neuroscientists come up with an objective way to quantify various degrees of happiness, such that they can coherently talk about Mary being ‘three times more satisfied’ than Bill.” (Murphy 2010: 41).

That admission requires that, despite what vulgar Austrians think, at least in principle subjective utilities are comparable, and that it might even be possible to one day obtain a scientific quantification of the intensity and nature of human emotions underlying utility, with some objective unit of measurement.

At that point, the Austrian claim that subjective utilities cannot be objectively measured will have been refuted.

Thursday, August 21, 2014

The Post Keynesian view on labour markets is opposed to that of neoclassical economics. A summary of Post Keynesian labour market theory from Lavoie (1992) follows.

Post Keynesian economics holds that labour markets are not necessarily well behaved, that the wage rate is not an ordinary “price”, and that wages cuts can have perverse effects on economic activity contrary to neoclassical theory (Lavoie 1992: 217).

Wages are not, general speaking, set by reference to marginal product of labour, but wage rate determination is affected by notions of fairness, justice and social norms, and these factors can affect all attributes of labour from the real/nominal wage to productivity, working week, job safety, security and so on (Lavoie 1992: 218).

At the aggregate level, there is no necessary and consistent relationship between the real wage and demand for labour (Lavoie 1992: 217).

Even the neoclassical view that work necessarily carries disutility is untrue: work per se can be rewarding and bring satisfaction (Lavoie 1992: 218).

Lavoie (1992: 218) points to the dual labour market hypothesis, which is that most advanced economies have two sub-labour markets, as follows:

(1) the “core” economy labour market
Here wages and productivity are high, costs of labour training are high, and there is a greater degree of unionisation.

The administered pricing/mark-up pricing sector of an economy strongly corresponds to the “core” economy, though imperfectly.

A strong general characteristic of most households is that they wish to maintain their standard of living, and that they face fixed nominal contractual obligations like debt, and hence the need to maintain income levels (Lavoie 1992: 222). This, though amongst other reasons too, translates into a strong opposition to nominal wage cuts.

Even labour supply often depends on a perceived target wage rate and past standards of living (Lavoie 1992: 222–223), not necessarily on movements of the real wage rate.

The demand for labour is mostly driven by demand for output, and hence aggregate demand drives employment levels.

Wednesday, August 20, 2014

The Austrian argument against progressive taxation, from Robert P. Murphy’s Lessons for the Young Economist (2010), is as follows:

“If preferences are subjective to each individual, and cannot even be measured or quantified for each individual, then obviously it would make no sense at all to try to combine or aggregate individual preferences into ‘social’ preferences. Unfortunately, even professional economists often engage in just this type of reasoning. Many people (try to) justify progressive income taxation, for example, by claiming that ‘a dollar means more to a poor man than to a rich man.’ The idea is that taking $1 million from Bill Gates won’t lower his utility very much, whereas handing out $1,000 to a thousand different homeless people will greatly boost each of their utilities. Therefore, the typical argument goes, total or “social” utility has been increased by the redistribution of some of Bill Gates’s wealth.

… For now, we point out that the typical justification for it is absurd. You can’t add up different amounts of utility from various people. In fact, if you use the alternate term preferences it will be more apparent why combining them from different people is an impossible task.” (Murphy 2010: 42).

The trouble with this is that, just because it is impossible to aggregate the subjective utilities of different people or find some objective unit of measurement with which to make objective interpersonal utility comparisons, it does not follow that an economic argument for progressive income taxes, on basis of diminishing marginal subjective utility, has failed.

Of course, there are problems with the so-called “law” of diminishing marginal subjective utility, as I have shown here, but there is reason to think it is true as a generalised statement.

If any Austrian economist accepts the “law” of diminishing marginal utility (or accepts it merely as a general principle), it follows that a very rich person should, generally speaking, derive less utility from an extra dollar than a person who is very poor, even if one cannot measure the utility in some objective quantity like “utils.”

If indeed there is good reason to think that the value of an additional unit of income to a person who is already very rich is considerably less than the value of an additional unit to someone who is poor, then redistribution of income to promote happiness and reduce hardship has sound economic justification.

And indeed empirical evidence seems to show that as wealth rises, the happiness that one derives from additional income falls or levels off after about $70,000 (US) (e.g., a fascinating discussion of this topic here).

The argument against progressive taxation that we cannot objectively “measure” the utility lost by the rich man as compared with that gained by the poor man does not necessarily refute the argument from diminishing marginal utility: for it requires a highly unrealistic assumption, as we shall now see.

If we were to take two poor people both with the same income, and imagine one becoming extremely rich while the other remains poor, the argument against progressive income tax could only work if the utility the rich man derived from a unit of money while poor was vastly – and indeed unrealistically and extremely – greater than that of his fellow, so that as each additional unit of money the man received – even to very high levels like millions or billions of dollars – the diminished utility still remained so high that it exceeded that of his fellow who still remained poor.

Now of course individuals display variation and can and do have different degrees of subjective utility in terms of the satisfaction that they derive from any good x (and even from a unit of money), but to believe that all or most rich people derive greater utility from one unit of their money than a poor person from one extra unit again requires the ridiculous assumption that, if (hypothetically) or when (in reality) they were poor, all or most of these rich people derived a degree if utility vastly – and indeed unrealistically and extremely – greater than that of other poor people.

This, quite frankly, violates everything we know about human psychology, neuroscience and evolution. Human beings are all products of Darwinian evolution; they have the same fundamental biochemistry and neural processes in the brain; the mind and all its emotions, like happiness, satisfaction and pleasure, are causally dependent on brain processes. People do display individual variation in many traits – such as height, eye colour, and no doubt in what economists call utility – but not to the extent that average people have such a vast difference between them as would be required in the case we have imagined above.

But we need only think of height here. Most human beings have a height between 5 feet and 6 feet, and even exceptions (apart from highly usually things like dwarfism and gigantism) do not deviate too far from this range. Height is a product of genetics and environmental influences. There is every reason to think that the propensity to feel emotions like happiness, satisfaction and pleasure – the emotions that the word “utility” in an economic sense describes – are a product of genetics and environmental influences too, with individual variation, but not so vast that the utility felt by two average people while poor is so vastly different that one million dollars or $100 million – under the principle of diminishing marginal utility – given to one man would still not reduce his utility from one extra dollar to a level below that experienced by the other poor man from one extra dollar.

In short, Austrians, like neoclassicals, if they really accept the “law” of diminishing marginal utility without the ridiculous assumption we have identified above, then the economic argument for progressive taxation from diminishing marginal utility is hard to refute.

Of course, they might make a moral argument from Rothbardian natural rights or Hoppe’s argumentation ethics, but this is clearly a different type of argument from the one based on subjective utility.

Saturday, August 16, 2014

This is how it was explained and understood in a mid-19th century American legal text (from 1856):

“The relation which subsists between a banker and his customer seems to be this—‘The customer lends money to the banker, and the banker promises to repay that money, and, whilst indebted, to pay the whole or any part of the debt to any person to whom his creditor, the customer, in the ordinary way requires him to pay it.’ (l) The ordinary mode of paying off the debt due from the banker is by honouring cheques and bills made payable at the bank, where he has authority from his customer for that purpose.

BIBLIOGRAPHY
Broom, Herbert. 1856. Commentaries on the Common Law, Designed as Introductory to its Study (The Law Library v. 91, July, August, September and October, 1856). T. & J. W. Johnson & Co. Philadelphia.

Friday, August 15, 2014

“It may perhaps be pointed out here that it has, of course, never been denied that employment can be rapidly increased, and a position of ‘full employment’ achieved in the shortest possible time by means of monetary expansion–least of all by those economists whose outlook has been influenced by the experience of a major inflation. All that has been contended is that the kind of full employment which can be created in this way is inherently unstable, and that to create employment by these means is to perpetuate fluctuations.

There may be desperate situations in which it may indeed be necessary to increase employment at all costs, even if it be only for a short period–perhaps the situation in which Dr. Brüning found himself in Germany in 1932 was such a situation in which desperate means would have been justified. But the economist should not conceal the fact that to aim at the maximum of employment which can be achieved in the short run by means of monetary policy is essentially the policy of the desperado who has nothing to lose and everything to gain from a short breathing space.” (Hayek 1975 [1939]: 64, n. 1).

But this is at least a frank statement of what many Rothbardian Austrians these days cannot even bring themselves to admit: that the lack of government monetary and fiscal stability in early 1930s Germany was the primary cause of the surge in the popularity and electoral success of the Nazi party. It was deflationary depression, not hyperinflation, that destroyed democracy in Germany.

This can be seen in the Nazi party share of the vote in federal elections in the Weimar Republic from 1924 to 1933:

By 1928, during the economic boom in Germany, the Nazi party vote looked like it was almost dead and was only 2.6%. Remarkably, even in the aftermath of the Weimar hyperinflation in 1924 it was only 3%.

When the deflationary depression struck Germany from 1929–1932, it soared to 18.3% (September 1930), then 37.3% (July 1932), and finally to 43.9% in March 1933 in the aftermath of the Great Depression.

While Fazzari (2009) argues that the neutral money axiom is more a consequence of unrealistic models rather than a real axiom (Fazzari 2009: 6), the concept of neutral money holds that changes in the money supply will only affect nominal values (e.g., prices, money wages, etc.), not real variables (such as production, employment, and investment).

While most neoclassical economists are of course willing to concede that money is non-neutral in the short run, nevertheless most do think money is neutral in the long run (Davidson 2002: 41).

Keynes and Post Keynesians, by contrast, reject the view that money can ever be neutral even in the long run (Davidson 2002: 41).

The ergodic axiom holds that the probability of future events can be predicted objectively by means of statistical analysis from past data (Davidson 2002: 43). But the world contains many non-ergodic processes and phenomena where statistical data simply does not yield probabilities of this sort: that is, fundamental uncertainty is a real, frequent and ineradicable aspect of economic life.

The gross substitution axiom is the idea that every good can in theory be a substitute for any other good (Davidson 2002: 43). In essence, this means that the law of demand can be applied to all goods, assets (even financial assets on secondary financial markets) and money.

This is unrealistic. As the blogger “Unlearning Economics” puts it rather pithily,

“economic theory assumes there is a price at which all commodities will be preferred to one another, which implies that at some price you’d substitute beer for your dying sister’s healthcare.”
“The Illusion of Mathematical Certainty,” Unlearning Economics, July 10, 2014.
http://unlearningeconomics.wordpress.com/2014/07/10/the-illusion-of-mathematical-certainty/

But the problems with the law of demand actually run far deeper than this, as pointed out by Steve Keen.

The gross substitution axiom is also not realistic for a much more profound reason as pointed out by Keynes: when applied to both financial assets and newly produced goods, it does not necessarily work (Davidson 2002: 44).

Fundamentally, money and financial assets have zero or near zero elasticity of substitution with producible commodities:

“The elasticity of substitution between all (nonproducible) liquid assets and the producible goods and services of industry is zero. Any increase in demand for liquidity (that is, a demand for nonproducible liquid financial assets to be held as a store of value), and the resulting changes in relative prices between nonproducible liquid assets and the products of industry will not divert this increase in demand for nonproducible liquid assets into a demand for producible goods and/or services” (Davidson 2002: 44).

And once we see that money and secondary financial assets (as demanded as a store of value) have a zero or very small elasticity of production, it follows that a rise in demand for money or such financial assets (and a rising “price” for such assets) will not lead to businesses “producing” money or financial assets by hiring unemployed workers (Davidson 2002: 44).

All this is sufficient to damn the gross substitution axiom.

All in all, the three axioms that form the basis of neoclassical economics cannot be taken seriously.

Wednesday, August 13, 2014

This post is more an exercise in clarification than (for the moment anyway) criticism.

What is the Austrian view of the relation between subjective value and price?

As explained by Mises:

“In an exchange economy, the objective exchange value of commodities becomes the unit of calculation. This involves a threefold advantage. In the first place we are able to take as the basis of calculation the valuation of all individuals participating in trade. The subjective valuation of one individual is not directly comparable with the subjective valuation of others. It only becomes so as an exchange value arising from the interplay of the subjective valuations of all who take part in buying and selling. Secondly, calculations of this sort provide a control upon the appropriate use of the means of production. They enable those who desire to calculate the cost of complicated processes of production to see at once whether they are working as economically as others. If, under prevailing market prices, they cannot carry through the process at a profit, it is a clear proof that others are better able to turn to good account the instrumental goods in question. Finally, calculations based upon exchange values enable us to reduce values to a common unit. And since the higgling of the market establishes substitution relations between commodities, any commodity desired can be chosen for this purpose. In a money economy, money is the commodity chosen.

Money calculations have their limits. Money is neither a yardstick of value nor of prices. Money does not measure value. Nor are prices measured in money: they are amounts of money. And, although those who describe money as a ‘standard of deferred payments’ naively assume it to be so, as a commodity it is not stable in value. The relation between money and goods perpetually fluctuates not only on the ‘goods side,’ but on the ‘money side’ also. As a rule, indeed, these fluctuations are not too violent. They do not too much impair the economic calculus, because under a state of continuous change of all economic conditions, this calculus takes in view only comparatively short periods, in which ‘sound money’ at least does not change its purchasing power to any very great extent.” (Mises 2009: 115).

Two points here:

(1) according to Mises, and as he says elsewhere, what is needed for economic calculation is money prices for factors of production and consumer goods. As long as the general price level does not fluctuate too sharply, these two factors – (1) money prices and (2) mild or modest inflation or deflation rates – are sufficient for economic calculation.

(2) the second important point is here:

“Money calculations have their limits. Money is neither a yardstick of value nor of prices. Money does not measure value. Nor are prices measured in money: they are amounts of money.”

At first sight, point (2) seems a curious statement, but the crucial point that Mises seems to be making is that there is no objective unit of measure for value as defined as subjective utility:

“In the market, exchanges will occur until there are no more mutually beneficial trades. The underlying subjective valuations driving acts of exchange do not involve a ‘measurement’ of value. (For an analogy, someone can rank his friends in order of importance, without implying that there is an objective unit of friendship that the person measures in each person before constructing the ranking. Someone can report, ‘Jim is my best friend and Sally is my second-best friend’ without being able to say, ‘Jim is a 24 percent better friend than Sally.’) All that is necessary is that a person be able to look at any two possibilities, and decide which he prefers.

Even though market exchanges are driven by subjective valuations that are themselves nonquantifiable, nonetheless these exchanges in turn give rise to objective exchange ratios or prices.” (Murphy 2011: 14).

“If we are referring to subjective value, then there is no ‘unit’ of measurement at all. Suppose we take an old photograph of Jill’s grandmother, and ask Jill, ‘Do you value this object?’ Jill might say, ‘Yes, very much so.’ Then we hold up her calculator, and ask if Jill values it as well. Jill might say, ‘Yes, but not as much.’

Finally, we ask Jill, ‘By what percentage does your valuation of the photograph exceed your valuation of the calculator?’ Jill would be unable to answer such a nonsensical question. She can rank the two objects according to her subjective tastes; she can report that she values the photograph more than the calculator. But this doesn’t imply that there are cardinal units of psychic satisfaction, with the photograph bestowing more units than the calculator.”
Murphy, Robert P. 2011. “Subjective Value and Market Prices,” Mises Daily, February 7
http://mises.org/daily/4907/Subjective-Value-and-Market-Prices

The upshot is, according to Austrians, that subjective value cannot be measured with any objective unit at all, but market prices are objective as units of money that emerge in exchanges between buyers and sellers.

Tuesday, August 12, 2014

“In the absence of money production-hire contracts over time in a nonergodic environment, entrepreneurs would be foolish to start up a long duration production process, for they would not possess any knowledge of the ultimate future costs of production! (How could a profit-maximising manager calculate the marginal cost associated with varying production flows, in a nonergodic world, without fixed nominal wage contracts?) The institution of forward money contracts where delivery and payment is specified at a future date is an institutional arrangement which permits agents to deal with, and control the outcomes of, an otherwise uncertain future. Long-lived forward contracts are the way a free market economy, in an uncertain world, builds in institutional price and wage stickiness over time. In a nonergodic world, such explicit money contractual anchors for future events are necessary conditions for encouraging entrepreneurs to carry out economic activities in a market economy” (Davidson 1988: 335).

Of course, we can add mark-up pricing/administered pricing to nominal contracts as well.

The rise of a high degree of price and wage rigidity in modern economies is, contrary to neoclassical theory, a development that many businesses actively desire because it promotes stability and increases their ability to successfully plan for the future. In that sense, contrary to Austrian and neoclassical theory, relative price and wage rigidity greatly aids economic calculation, because such rigidity allows more successful forward planning.

Both fixed nominal contracts and administered prices are simply private sector institutions to decrease the uncertainty that economic agents face when dealing with an unknown future: they have emerged from within markets, and are not some artificial or unnatural imposition on markets.

In this new post, the author shows that, although there were some confusions, nevertheless Rothbard’s idea that in England “bailment law scarcely existed until the eighteenth century” (Rothbard 2008: 89) cannot be taken seriously.

“Most, if not all, booms and busts originate with excess credit creation from the financial sector. These respondents, incorrectly, assume that this financial system structured on fractural reserve banking is an integral part of capitalism. It isn’t. It is fraud and a violation of property rights, and should be treated as such.

In the past, we had deposit banks and loan banks. If you put your money in a deposit bank, the money was there to pay your rent and food expenses. It was safe. Loan banking was risky. You provided money to a loan bank knowing funds would be tied up for a period of time and that you were taking a risk of never seeing this money again. For this, you received interest to compensate for the risk taken and the value of time preference. Back then, bankers who took a deposit and turned it into a loan took the risk of shortly hanging from the town’s large oak tree.

First of all, throughout Western civilisation the essence of banking has always been the mutuum contract, not the bailment (or depositum regulare).

There is very little evidence that, when banks arose either in the ancient world or the Middle ages and early modern period, their main activity was mere bailment, and that they had to steal their depositors’ money to engage in lending.

On the contrary, the bankers always had recourse to the mutuum contract, where money is lent to a banker and the money becomes the banker’s property. The client of the banker gets an IOU in return and the debt can be recalled (1) on demand, (2) in stipulated payments, or (3) on a certain date (as in a fixed term loan).

The free banker George Selgin has demonstrated that Rothbard’s view of the origin of fractional reserve banking in Britain under the goldsmiths cannot be accepted as true (Selgin 2011).

Two major pieces of evidence that even these early English goldsmiths were mostly engaged in mutuum lending are that (1) they paid interest and (2) the earliest British goldsmiths’ notes are IOUs or negotiable debt instruments payable on demand (Selgin 2011: 11), which explicitly demonstrates to us that these were debt records and the underlying contract a mutuum, not bailment.

For example, if we turn to Henry Dunning Macleod, one of the outstanding historians of banking in Great Britain, we find that this is exactly how he explains the origin of banking under the London goldsmiths:

“It was during the great civil war, as we have already explained, that the goldsmiths of London first began to receive the cash of the merchants and country gentlemen for safe custody, on condition of repaying an equal sum on demand, and to discount bills of exchange with their own promissory notes; that commenced the business of banking. Now, this money was not placed in their hands to be locked away in their cellars, as plate and jewelry are often given into the custody of a banker for mere safe custody as a depositum, and to be restored in specie. The money was sold to the banker to become his actual property, according to the well-understood custom of bankers; that is, it was a mutuum or creditum; and was to be restored only in genere. The goldsmith bankers agreed not only to repay the money on demand, but also to pay six per cent, interest upon it. Consequently, in order to make a profit, they were obliged to trade with it.” (Macleod, in Macleod et al. 1896: 203).

Although there were “banks of deposit” in mainland Europe in the early modern era (although even here it is not straightforwardly clear whether the relation between client and banker was a strict bailment: Macleod, in Macleod et al. 1896: 201–202), the idea that modern banking only emerged because “deposit bankers” who simply held money as a bailment had to steal their clients’ funds has little evidence to support it.

Nor is this true:

“During the early part of the nineteenth century, the deposit function and loan function were merged into a new entity called a commercial bank. Of course, very quickly these new commercial banks realized they could dip into deposits, essentially committing fraud, as a source of funding for loans. Governments soon realized that such fraudulent activity was a great way to finance government expenditures, and passed laws making this fraud legal. A key interpretation of law in the United Kingdom, Foley v. Hill, set precedence in the financial world for banking laws to follow …”Frank Hollenbeck, “Confusing Capitalism with Fractional Reserve Banking,” Mises Daily, August 6, 2014.

The Austrians’ false belief that in the 19th century the “deposit function and loan function were merged into a new entity called a commercial bank” is derived from an ignorant and shoddy reading of legal history by Murray Rothbard. Rothbard thought the Carr v. Carr and Foley v. Hill cases in England legalised theft by banks of depositors’ bailments.

But neither of these cases set any such “precedent” imagined by Austrians.

What totally destroys the Austrian reading of Carr v. Carr is that even the lawyers Hart and Wetherell, acting for the defendant, admitted that, strictly speaking, the cash balance at the bank was legally a debt, and not a bailment.

Far from being some “fraud” or unnatural system grafted onto capitalism, fractional reserve banking is a fundamental part of capitalism, and the Austrian view of it is a travesty both history and economics.

Thursday, August 7, 2014

First, it is important to note that the “libertarianism” we are talking about here is an extreme form called Rothbardian anarcho-capitalism which believes in the total abolition of the state and the privatisation of everything.

Unfortunately, the problems with such a system go far beyond the issue of who would build the roads.

What would such a society look like? What would you discover if you woke up and found yourself in such a society?

To answer this question, we can turn to the writings of Rothbard to see how he imagines his anarcho-capitalist world (Rothbard 2009; 2011), and we can also use inductive arguments by analogy to suggest probable outcomes in such a society, on the basis of instances in modern history where modern nations (usually during the 19th century) have left things to private enterprise.

First, would an anarcho-capitalist society have a good system of transportation, sanitation, drainage, water, and electricity infrastructure, if built from nothing?

The Rothbardians claim that the private sector would build all such infrastructure, but historical instances where these things are left to the private sector suggest that such a system has definite disadvantages: not enough provision of such goods/services, and often privatised services which are too expensive for many people to afford (e.g., health care).

A case in point: if you found yourself in a Rothbardian anarcho-capitalism system, I submit that you would quickly find serious problems with justice.

The anarcho-capitalism system abolishes the state and all state-based criminal law. There would no longer be any criminal laws at all (Rothbard 2011: 407).

All crimes – even the worst possible – would simply become offences only punishable under a system of private tort law. In “common law” nations, a tort is a wrongful or harmful act against a person other than breach of contract (in “civil law” nations torts are generally called “delicts”). Under tort law, the victim can obtain redress or justice only if they privately bring a law suit or legal action against the perpetrator or aggressor (Rothbard 2011: 407). But what if you do not know the perpetrator or aggressor? You would need to hire private investigators even before you can bring a law suit.

But, unfortunately, both private investigators and law suits require money, and probably a considerable amount of money: if a victim cannot afford legal services and the fees to bring a private law suit under tort law, then no trials or punishments of many criminals will ever happen in Rothbardian anarcho-capitalist paradise.

More importantly, the principle of no public investigation or punishment of crimes through criminal law when a criminal, even if caught, can simply buy off his victim strongly suggests that the rich and super-rich in Rothbard’s world will simply have a licence to commit crimes and bribe victims to stop prosecution. This is a world where justice has become a travesty and a joke.

Let us move on to social security. You would also find that, if there is no basic social security in society, people who cannot find work or successfully beg for private charity in such a society will be plunged into poverty or simply starve. There would presumably be insurance against unemployment and other social distress, but we are now back to the same problem as noted above: what if you cannot afford it?

Rothbardian anarcho-capitalism would also be horrible for many of the mentally ill or disabled. What would happen to people who are mentally ill or disabled who simply cannot pay for basic services they need to live? What if these people cannot find enough charity?

Rothbardian anarcho-capitalism has no restrictions on child labour. What is particularly stupid here is that some libertarians, agreeing that child labour is a bad thing, are anxious to argue that you do not need child labour laws to end employment and exploitation of children.

However, if you bother to read Rothbard, he was actually in favour of child labour (Rothbard 2009: 1111–1112). A Rothbardian anarcho-capitalist system, then, has no barrier to exploitation of children.

With no public health policies such as immunisation programs and disease control, you would probably find that a Rothbardian anarcho-capitalist system would see the return of serious epidemics, diseases, and other serious public health issues long since banished from the Western world.

With no regulation of who brings in plants and animals into the society, will visitors or tourists bring in plant and animal diseases causing serious problems to agriculture and the environment?

Finally, with no government regulations whatsoever on the production and sale of not only guns, but also advanced military weapons, chemical, biological, and nuclear weapons, it follows that any lunatic or religious fanatic with enough money can literally go and freely buy weapons of mass destruction, without anyone stopping them, in a Rothbardian anarcho-capitalist world.

Libertarians have a major problem: there are very few people indeed who would want such a society or think that it would be a good place to live in.

In reality, on the last issue alone (lack of any regulation on production and sale of the most destructive weapons imaginable), most people would conclude that such a society sounds completely, utterly, stark, raving mad – Rothbard’s bizarre fantasies and intellectually bankrupt natural rights ethics notwithstanding.